5.8. TEST YOUR UNDERSTANDING 217
4.8.2 Applications
- Michael Milkem, an ambitious MBA student from Anchorage, Alaska, is look-
ing for free lunches on the foreign exchange markets. Keeping his eyes glued to
his Reuters screen until the wee hours, he spots the following quotes in Tokyo:
Exchange rate: Spot nzd/usd 1.59–1.60 jpy/usd 100–101
nzd/gbp 2.25–2.26 jpy/gbp 150–152
180 - day Forward nzd/usd 1.615–1.626 jpy/usd 97.96–98.42
nzd/gbp 2.265–2.274 jpy/gbp 146.93–149.19
Interest rates (simple,p.a.)
180 days usd 5%–5.25% jpy 3%–3.25%
nzd 8%–8.25% gbp 7%–7.25%Given the above quotes, can Michael find any arbitrage opportunities?- us-based Polyglot Industries will send its employee Jack Pundit to study Dan-
ish in an intensive training course in Copenhagen. Jack will needdkk10,000
at t = 3 months when classes begin, anddkk6,000 at t = 6 months, t =
9 months, and t = 12 months to cover his tuition and living expenses. The
exchange rates and p.a. interest rates are as follows:
dkk/usd Exchange rate p.a.interest rateusd p.a.interest ratedkkSpot 5.820–5.830
90 days 5.765–5.770 3.82–4.07 8.09–8.35
180 days 5.713–5.720 3.94–4.19 8.00–8.26
270 days 5.660–5.680 4.13–4.38 7.99–8.24
360 days 5.640–5.670 4.50–4.75 7.83–8.09Polyglot wants to lock in thedkkvalue of Jack’s expenses. Is the company
indifferent between buyingdkkforward and investing indkkfor each time
period that he should receive his allowance?- Check analytically that a money-market hedge replicates an outright forward
transaction. Analyze, for instance, a forward sale ofdkk1 againstnzd.
Exercises 4 through 6 use the following time-0 data for the fictitious currency,
the Walloon Franc (waf) and the Flemish Yen (fly), on Jan. 1, 2000. The
spot exchange rate is 1waf/fly.
Interest rates Swap rate
fly waf waf/fly
180 days 5% 10.125% 0.025
360 days 5% 10.250% 0.050